Capitalism and the Origin of Economic Institutions

by | Jun 6, 2022 | Economics

Economic progress is the leading manifestation of yet another major institutional feature of capitalism: the harmony of the rational self-interests of all men, in which the success of each promotes the well-being of all.

An excerpt from Chapter 1 of Capitalism: A Treatise on Economics, Volume I.

To the degree that they exist, freedom and the pursuit of material self-interest, operating in a rational cultural environment, are the foundation of all the other institutions of capitalism. And the study of these institutions and their functioning is the substance of the science of economics.

If individuals both possess freedom and, at the same time, rationally desire to improve their lives and well-being, then they have only to use their minds to look at reality, consider the various opportunities that nature and the existence of other people offer them for serving their self-interest, and choose to pursue whichever of the opportunities confronting them they judge best. They can do whatever they judge is most in their self-interest to do, provided only that they do not initiate the use of force against others.

What people do in these circumstances is spontaneously to set about establishing, or extending and reinforcing, all the other institutions, in addition to freedom and limited government, that constitute a capitalist economic system, such as private ownership of the means of production, saving and capital accumulation, exchange and money, division of labor, and the price system.

Thus, in pursuing their rational self-interest under freedom, they appropriate previously unowned land and natural resources from nature and make them into private property and thus privately owned means of production. Private property in products, including capital goods, then follows on the basis of private property in land and natural resources: the owners of land and natural resources own the products that result from them, including those which they use as means of further production. In addition, of course, they can exchange their products with others for services. These others then also own products, including capital goods, and can, of course, obtain land and natural resources from their original owners by means of purchase or, in primitive conditions, barter exchange.

Being secure in their possession of property from violent appropriation by others, and rational enough to act on the basis of long-run considerations, individuals save and accumulate capital, which increases their ability to produce and consume in the future (for example, following the appropriation of land, they clear trees, remove rocks, drain, irrigate, build, and do whatever else is necessary to establish and improve farms and mines and, later on, commercial and industrial enterprises).

They also perceive the advantages of establishing division of labor and performing exchanges with others. They perceive that some individuals are more efficient than others in the production of certain goods, whether by reason of personal ability or because of the circumstances of the territory in which they live, and that an advantage is to be gained by individuals concentrating on their areas of greater efficiency and exchanging the results.32

They perceive the advantages of indirect exchange—that is, of accepting goods not because they want them themselves, but because others want them and the goods can thus be used as means of further exchanges. Out of indirect exchange money develops, with the result that the division of labor is enabled radically to intensify—to the point where each individual finds it to his interest to produce or help to produce just one or at most a very few things, for which he is paid money, which he in turn uses to buy from others virtually all that he himself consumes.33

In the context of a division-of-labor, monetary economy, the individual’s pursuit of his material self-interest gives rise to the narrower principle of financial self-interest—that is, of preferring, other things being equal, to buy at lower prices rather than higher prices and to sell at higher prices rather than lower prices. These are the ways to increase the goods one can obtain by the earning and spending of money. In combination they represent the profit motive—the principle of “buying cheap and selling dear.”

The individual’s pursuit of self-interest also gives rise to economic inequality, as those who are more intelligent and ambitious outstrip those who are less intelligent and ambitious; and to economic competition, as different sellers seek to sell to the same customers, and as different buyers seek to buy one and the same supply of a good or service.

The combination of the profit motive and the freedom of competition, in turn, constitutes the basis of the price system and all of its laws of price determination.

Thus, rational self-interest and the individual’s freedom to act on the basis of it underlie private property and private ownership of the means of production, saving and capital accumulation, the division of labor, exchange and money, financial self-interest and the profit motive, economic inequality, economic competition, and the price system—in a word, the whole range of capitalism’s economic institutions.

The combined effect of these institutions is economic progress—that is, the increase in the productive power of human labor and the consequent enjoyment of rising standards of living. Economic progress is the natural accompaniment of rationality and the freedom to act on it. This is so because the continued exercise of rationality creates a growing sum of scientific and technological knowledge from generation to generation. This, together with the profit motive, the freedom of competition, the incentive to save and accumulate capital, and the existence of a division-of-labor society, is the essential basis of continuous economic progress.34

Economic progress is the leading manifestation of yet another major institutional feature of capitalism: the harmony of the rational self-interests of all men, in which the success of each promotes the well-being of all. The basis of capitalism’s harmony of interests is the combination of freedom and rational self-interest operating in the context of the division of labor, which is itself their institutional creation. Under freedom, no one may use force to obtain the cooperation of others. He must obtain their cooperation voluntarily. To do this, he must show them how cooperation with him is to their self-interest as well as his own, and, indeed, is more to their self-interest than pursuing any of the other alternatives that are open to them. To find customers or workers and suppliers, he must show how dealing with him benefits them as well as him, and benefits them more than buying from others or selling to others. As will be shown, the gains from the division of labor make the existence of situations of mutual benefit omnipresent under capitalism.35 The division of labor, in combination with the rest of capitalism, represents a regular, institutionalized arrangement whereby the mind of each in serving its individual possessor, serves the well-being of a multitude of others, and is motivated and enabled to serve their well-being better and better.

In sum, capitalism, with its economic progress and prosperity, is the economic system of a free society. It is the economic system people achieve if they have freedom and are rational enough to use it to benefit themselves. As I have said, it represents a self-expanded power of human reason to serve human life.36

Excerpted from Chapter 1 of Capitalism: A Treatise on Economics, Volume I. Copyright 2020 George Reisman. All rights reserved. The encyclopedic Capitalism: A Treatise on Economics is a required reference for every Capitalist’s library. Reisman’s treatise is now available in two volumes: Volume I (focuses on microeconomic issues) and Volume II (focuses on macroeconomic issues).


32. Concerning the fact that the division of labor originates on the basis of differences in human abilities and in the conditions of people’s natural surroundings, see von Mises, Socialism, pp. 292-293.
33. On the fact that money originates in the self-interested actions of individuals, see Carl Menger, Principles of Economics (Glencoe, Ill.: The Free Press, 1950), pp. 257-262. See also below, pp. 506-517.
34. These factors also operate to create a steadily growing supply of useable, accessible natural resources. See below, pp. 63-67.
35. See below, pp. 123-133.
36. See above, p. 19.

George Reisman, Ph.D., is Pepperdine University Professor Emeritus of Economics and the author of Capitalism: A Treatise on Economics. See his author's page for additional titles by him. Visit his website and his blog Watch his YouTube videos and follow @GGReisman on Twitter.

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

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